Destabilizing Speculation and the Case for an International Currency Transactions Tax

Challenge,  May, 2001  by Thomas Palley

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Is a Tobin Tax Feasible?

The theoretical case for a Tobin tax represents only one part of the debate. Equally important is the question of whether a Tobin tax is feasible. Critics claim that it is not. One criticism focuses on "avoidance through jurisdictional shopping," while a second focuses on "avoidance through changed product mix."

With regard to the former, the principal objection to the Tobin tax rests on the claim that it needs to be applied on a global basis in a coordinated, uniform fashion. If it is not, currency traders will have an incentive to engage in "jurisdictional shopping," and markets will just shift their activities away from countries with the tax to countries without it.

Although some jurisdictional shopping would exist in the absence of uniform application, there are a number of reasons to believe that this effect would be inconsequential--especially if the tax were to be applied among a significant group of countries such as the G-7. This prediction derives from the Bank for International Settlement's (BIS) experience with capital standards that in many regards exactly parallel the Tobin tax. These standards impose an additional cost on banks by asking them to hold more costly equity capital, and banks therefore have an incentive to evade them by shifting to jurisdictions where they are not applied. Yet, there is no evidence that this shift has occurred. Instead, conforming to the BIS standards has become the equivalent of a seal of good housekeeping, which has given governments an incentive to apply and enforce them in order to retain good standing and attract business to their financial markets. Despite being subject to the threat of jurisdictional shopping, governments have still managed to come together to make BIS standards the law. This experience illustrates how enforcement of the Tobin tax is a matter of "political will" and that enactment of a Tobin tax by even a few large countries could quickly make it the de facto standard of governance that pulls the rest in. [6]

Furthermore, such a process of establishing a de facto global standard is facilitated by the fact that currency trading is highly concentrated. Using 1995 data, Felix (1996) reports that 62 percent of trading takes place in the top five markets (United Kingdom, United States, Japan, Singapore, and Hong Kong) and that 84 percent takes place in the top nine (top five plus Switzerland, Germany, France, and Australia). If these countries, plus the remaining G-7 member countries (Italy and Canada), were to impose a Tobin tax, it would capture the vast bulk of the world's markets.

Not only would it be feasible for the G-7 to go it alone in imposing a Tobin tax, Baker (2000) suggests that the United States could successfully impose a Tobin tax unilaterally. The bottom line is that a Tobin tax would fractionally raise the cost of doing business, but the United States is one of the world's low-cost producers of financial services. Thus, the small induced increase in the cost of doing business would not necessarily result in much loss of business to other markets. Decisions about where to locate dealing do not depend exclusively on narrow transactions costs. They are also influenced by the business environment, the network of other support services and ancillary markets, and the soundness of the regulatory system governing the conduct of business. All of these factors work to the advantage of U.S. markets, so that a small Tobin tax need not be critical in the business-location decision.